The evolution of relational contracts

As we all know, too many contracts fail to deliver expected results.

Growing complexity, market volatility, increased interdependence – there are multiple factors that contribute to those failures and are forcing change in the way that organizations interact. Relationships are often too vague, too reliant upon individual memory, to be sustainable ways of managing the performance of commitments and obligations. Contracts, on the other hand, are often too limited in the ground they cover and too difficult to understand and interpret. Traditional approaches to relationship management and contract management are no longer ‘fit for purpose’.

As a result of these changing needs, relational contracting – the integration of the relationship terms into the contract – has been an evolving reality, rather than a planned development. There are no generally accepted model ‘relational contracts’. Indeed, even research into the elements of a relational contract is limited. IACCM has developed core principles – for example, methods and types of communication, the importance of balanced incentives, approaches to problem solving – and is consolidating various research initiatives, but this remains at a relatively early stage. Individuals such as Andy Akrouche and Kate Vitasek have also led the charge in trying to define methodologies that support ‘collaborative relationships’.

Now, there is growing interest by the legal profession and by the courts in making sense of relational agreements, with a number of recent cases highlighting these developments. Andrew White, a partner at law firm Bird & Bird, presented at a recent IACCM UK member meeting and explained some of the impacts. For example, he observed that: “As contracts move towards clearer obligations, remedies move towards an obligation to perform rather than damages”. Such a shift has potentially massive significance, especially on issues such as ‘hardship’. Of even greater import, perhaps, is the increasing use of concepts of ‘good faith’ and their legal enforceability. This is a very new concept in most common law jurisdictions (in the US, it has been a traditional element of law, yet rarely seems to be imposed).  For example, the English Court of Appeal recently concluded that contracts have two distinct elements – a performance element and a risk allocation element – and the performance element relies heavily on issues of intent.

So the law is catching up with commercial reality. But commercial reality still has far to go in designing approaches to business engagement that deliver better results. Partly this relates to better and more constructive approaches to market evaluation and subsequent negotiation. For example, suppliers are often held at arm’s length and there are too few opportunities to establish what it might be possible to achieve. Requirements and capabilities are frequently misaligned. Organizational culture or integrity rarely feature in selection criteria. Resources are fragmented, required skills overlooked. The list goes on. But at its heart, while we are beginning to understand the concept of relational contracting, we are not exploring its implications to the way we design, manage or motivate our internal organization or our external trading relationships. Simply writing things into a contract does not make them a reality.

Experience shows that most organizations can develop highly successful collaborative relationships. It also shows that most of them are unable to replicate those successes. In other words, they can occasionally rise to the challenge of doing things differently, but they cannot sustain the effort. They soon revert to form – and that form is generally one where trust is limited, cooperation is an exception and a readiness to blame takes over from a sense of shared responsibility.

This means we have a situation where contracts could be used to reengineer the company. By recognizing the nature of the commitments and governance procedures needed for successful outcomes, an organization can reverse engineer the required capabilities, measurements and management systems (an approach used successfully by the IBM Corporation during a past era of rapid market change). This, in fact, is what lies at the heart of ‘commercial excellence’ – another of the major topics being addressed at IACCM and delivered through its training programs. Unfortunately, senior management rarely thinks of contracts in this way. And that is a missed opportunity.